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ComCom pushes Fonterra on impact of carbon reductions

Thursday 15th August 2019

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The Commerce Commission wants more information from Fonterra Cooperative Group on what it thinks the cost of cutting carbon emissions will have on the milk price paid to farmers. 

Fonterra’s manufacturing sites source around 40 percent of their current processing energy from coal, but won't commission any new coal boilers as part of the dairy exporter's plans to cut emissions by 30 percent across all manufacturing operations by 2030 and achieve net zero emissions by 2050.

As a result, the commission wants to know how Fonterra's decarbonisation plans have or will be factored into the base milk price calculation models, and over what timeframes.

The regulator is required to review Fonterra’s base milk price calculation at the end of each dairy season under the monitoring regime in the Dairy Industry Restructuring Act. It released a draft report today and will take submissions until Sept. 2.

The base milk price is the average price that Fonterra pays farmers for raw milk, which was calculated at $6.35 per kilogram of milk solids for the 2018/19 dairy season. 

Fonterra said the current calculation takes its actual mix of energy sources by site and "as alternative energy sources are used by Fonterra on its commodity ingredients sites, the milk price model will begin using those sources at the same time, and in the same proportions, as Fonterra." 

The commission said that while no changes to investments in alternative energy warrant an adjustment to the 2018/19 price, “any investments in the future will have to be considered in further detail.” 

It noted increasing public concern about the significant impact of dairy activities on the environment, which is also driving better management of processing effluent and water use as well as changes in the use of energy to reduce emissions.

Fonterra has recently installed a water-recycling innovation at its Pahiatua plant that will save about a half a million litres of water a day during the processing season, the report said.

Also driving changes to plant and processing costs are more stringent resource consent requirements.

Fonterra told the commission the milk price calculation does not explicitly factor in any environmental costs but the costs of obtaining resources consents are part of the firm's capital costs.

It also said that the 2020 financial year is a “reset” year for capital costs and “we will therefore be revisiting these allowances as part of that process.”

In recent years, Fonterra has typically spent around $1-$1.5 million a year renewing two to five consents related to water take, discharge to air and wastewater, the commission said.

This annual spend has doubled over the past 10 years. Fonterra has estimated the cost of renewing an individual consent can vary between $40,000 and $1 million. 

The Commerce Commission said this year's draft review of Fonterra's 2018/19 milk price calculation revealed no new areas of concern. However, the commission said it lacked the necessary information to reach a view on the dairy giant's administration and overhead costs and it still thinks Fonterra's asset beta is too high.

A beta is a measure of the volatility, or systemic risk, of a security or a portfolio in comparison to the market as a whole. A beta of less than 1 suggests the security is theoretically less volatile compared to the wider market, meaning a lower asset beta allows a higher milk price to be paid. 

“We’re satisfied that Fonterra’s calculation is largely consistent with both the efficiency and contestability purposes of DIRA, though we have been unable to reach a view on administration and overhead costs due to a lack of timely information from Fonterra," said commission deputy chair Sue Begg.

Approximately $45 million of additional costs have been included in the provisions for administration and other overhead costs for the 2018/19 season, the commission said.

Fonterra did not quantify the additional costs, but explained that the increase is to account for higher-than-inflationary movements in some categories of costs and changes in the external environment.

"We consider that an increased level of costs, absent any significant change in other assumptions or in the operating environment, must also be practically feasible and therefore consistent with the contestability dimension," Begg said.

"We have not been able to reach a conclusion on whether the assumptions, inputs and process underlying the calculation of administration and other overhead costs provide an appropriate incentive to Fonterra to operate efficiently."

She also said the commission retains its view that the asset beta Fonterra applies is "unlikely to be practically feasible."  

Based on additional material provided by Fonterra and after commissioning its own independent advice it "reaffirms the conclusion from our 2017/18 calculation review that an efficient processor with a similar risk exposure to the notional producer is unlikely to have an asset beta as low as Fonterra’s estimate." 

In March, Fonterra provided the commission with an independent expert report on the asset beta it applies. “We asked economic consulting firm CEPA to review Fonterra’s report. We are of the view that Fonterra’s new report doesn’t raise any new arguments,” Begg said.


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